“The area between SPX 3,812 and 3,850 has not exactly been an area at which major pivots have occurred in 2022, but it has been a zone at which the SPX has ‘chopped around’ for brief periods this year, as we experienced in June-July and late-October into mid-November… from both a technical perspective and an option-related perspective, the 3,800-3,812 area becomes an important lower support area in the week ahead for bulls.”
- Monday Morning Outlook, December 22, 2022
The levels described in the above excerpt from last week’s commentary, which were very much in play during standard December expiration week, continued to be in play during the last week of the year.
In fact, unlike past periods in 2022 when these levels were touched on multiple days within a given time as described in the excerpt above, the “chop-fest” since Dec. 19 has been much narrower in scope.
For newcomers to this commentary, I had mentioned several times throughout 2022 that the S&P 500 Index (SPX—3,839.50) at 3,850 could be viewed as important, as it was the close when U.S. President Joe Biden took office in 2021. The 3,812 level represents a round 20% below 2021 year-end close, which is a negligible 12 points above the round 3,800-century mark. Plus, 3,837 is in the middle of these levels, and represents a round 20% below the January 2022 all-time closing high.
As we enter 2023, bulls and bears are at risk as to how the current range ultimately resolves itself.
Does it represent a pivot area from which stocks reverse the sharp selling that occurred after the FOMC meeting earlier this month? Or is it simply a hesitation zone before the selling resumes?
If you are a trader, you should be prepared for both scenarios. For bulls, there is disappointment in the market’s behavior in the second half of December, as this period has historically delivered the strongest returns in the most consistent manner relative to other half-month periods throughout the year. For more on this historical seasonality, see Senior Quantitative Analyst Rocky White's Indicator of the Week posted on our web site on Dec. 14. The good news in regard to seasonality is that the first half of January has delivered gains 62% of the time during the past 50 years, albeit those gains are relatively muted, historically.
While we flip the calendar into a new year, some of the SPX levels that were important last year should continue to be on your radar. For example, if the SPX rallies, the first level of potential resistance is at the 3,900-century mark, site of resistance in September and early November, which was also the breakdown level below a trendline connecting higher lows from June through early September. Coincidentally, the 3,900 mark is also the current site of the SPX’s 50-day moving average, as seen below, which is popular among many technicians.
If the current range resolves itself to the downside, the 3,650 - 3,680 area is the first line of defense. That lower rung at 3,650 is the site support from an extended trendline connecting lower highs from August through October. It acted as support in the days following the breakout above this trendline at 3,680 in mid-October.
Turning to the longer-term, it was last year around this time that investors were unpacking the Fed’s late-November warning that the end of easy money was on the immediate horizon. However, the Fed took the market by surprise, raising rates at a faster and higher clip than it had forecast. This proved costly for the broader market, particularly technology stocks.
After a series of rate hikes that began in March 2022, investors still have the Fed front and center in their minds as they weigh whether the Fed can engineer a soft landing. Should the Fed not go as far as their own projections in regard to further rate hikes coincident with inflation coming down and the economy not suffering anything more than a short-lived, mild recession, stocks would be positioned to rally. However, if inflation lingers, and the Fed again has to raise rates more than projected, stocks may continue to recede. The best we can do is take technical cues from the broader market action.
With that said, one concern going into 2023 is the SPX’s monthly close back below its 36-month, or three-year, moving average. It is the second close below this moving average since September.
As I have said in the past, technical breakdowns like this have usually pointed to weak price action over the following weeks and months. At the same time, this moving average has marked the site of many significant troughs.
Usually, action around this long-term moving average is decisive. If it holds as support, V-rallies soon follow. And if a cross-under occurs, weakness occurs immediately. This time around, since June of last year, the SPX has been trading in a choppy pattern around this trendline, as neither the bulls nor the bears have gained significant control.
But even if the SPX recovers from this monthly close below the 36-month moving average, remember the trendline that has connected all major lower highs in 2022 as being a point of long-term resistance. The trendline comes into the new year at 4,009 and will be at 3,940 at the end of this month.
“…total short interest on SPX component names is at multi-year lows, and far below the levels that coincided with bottoms in 2018 and 2020 ... In fact, the long-term risk to bulls is the shorts returning in a big way, creating a long-term headwind after years of mostly covering activity that has been supportive.”
- Monday Morning Outlook, January 31, 2022
Finally, I think it makes sense to review a point I made around this time last year, as a risk to the bulls that played out in 2022 and could continue to play out.
That is, with the Fed raising rates more than it expected and unnerving investors, many stocks folded under this reality. And as you can see on the chart below, the shorts have come back after years of covering that was supportive of stocks, implying headwinds from not only the Fed, but those bearish bettors.
As we enter 2023, the Fed has made it clear that their work to fight inflation isn’t finished, nor is it close to being finished. And with the technical backdrop of both the SPX and Nasdaq-100 Index (NDX—10,939.76) not anything to write home about, the work of the shorts could be a continued headwind, at least for the first few months of 2023. The direction of the build in short interest is a continued risk after hitting multi-year lows last year around this time.
Todd Salamone is the Senior V.P. of Research at Schaeffer's Investment Research.
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